Why indexed insurance products may be the only game in town

By Steve Savant

I know I should recuse myself as an insurance purveyor with an obvious conflict of interest, but indexed insurance products may be the only the only game in town.

The S&P 500 lost four out of the last 10 years, a period that was dubbed the lost decade. Portfolios were decimated. Retirement dreams destroyed. And four years later, the consumer investor fear index is still on DEFCON One. But I’m not talking about the VIX, the S&P’s fear index of implied volatility in the S&P 500 index options market. That’s just a mathematical algorithm of probability of a market trend. I’m addressing the underlying investor phobia caused by the “cardiac-o-nomics” of 2008 that permanently cratered investor confidence and created the consumer fear index currently at zero risk tolerance. Investor paralysis over principal loss is so pervasive in the minds of most baby boomers that their money is making near nothing in taxable bank accounts. I know I should recuse myself as an insurance purveyor with an obvious conflict of interest, but indexed insurance products may be the only the only game in town.

Forget about the death benefit and the tax advantages of index insurance products. This is about not losing money. That’s not to say that those policy provisions are not appreciated by consumers. It’s just that principal preservation is the No. 1 issue that makes everything else secondary.

The underlying consumer fear index is now measured in sleepless nights. It’s assessed in the behavior that drives people to drink over their financial worries. It’s evaluated in the investor psyche that schedules appointments with therapists to somehow recover their self-worth after losing their net worth. It’s the new intolerance for principal loss. It’s the new zero risk tolerance that has now become the new norm.

So any investment with a beta risk greater than zero may be off the table as a viable investment option for most boomers. And what’s the cause of such angst but the paralyzing thought of principal loss and the pervasive investor belief of long term market instability? And adding to this boomer psychosis is the overwhelming reality of working to age 70 and the inescapable truth of a downsized lifestyle in retirement. The antidote is not some old in-it-for-the-long-haul investor mantra from some mutual fund marketing brochure. It’s the homespun wisdom of Will Rogers, “I'm not as concerned about the return on my money as I am the return of my money.”

Interestingly enough, during the lost decade, indexed insurance products credited solid single digit returns. The actual returns vary by each insurance contract because of varying caps, spreads and participation rates.
Index investing has always been an inexpensive way to play in the market. It’s the poor man’s portfolio with low expense loads. The inventory of indices is an asset allocator’s dream, going global with foreign indexes or staying down home on the farm domestic.

And when it comes to tax options, indexing can be taxable, tax deferred or tax free. Purchasing an index mutual fund will be taxable on all gains. In a non-qualified annuity contract, gains are tax deferred. And in a non-modified endowment contract (MEC), gains may be tax free whether it’s index or variable universal life insurance (VUL).

It’s important to note that buying index mutual funds or inside a variable universal life contract includes dividends, and dividends make up a significant portion of S&P 500 gains. But even the potential for dividends may not be enough to overcome the potential of losing money. And in this environment, not many have the stomach to expose their retirement dollars to another crash or double dip recession. In contrast, indexed annuities and indexed universal life insurance contracts don’t participate in dividends, have limitations on gains, but can’t lose principal based on market losses. So, during the bad boy years of 2001, 2002 and 2003, there was no negative assessments against the account values. Nevertheless, there was still three years of compound losses due to policy expenses.

Of course, there are expenses with indexed mutual fund, annuities or life insurance. And because no one can predict the performance of any index nor can you use historical data to tout the future, you’re left selling the investment or insurance costs and the tax advantages with the insurance products.

Accurately gauging consumer attitudes on the fear of principal loss can be somewhat measured by using a risk tolerance test with customers. The tests generally included a battery of questions with numerical weighting that resulting in a score that rates the customer’s propensity for risk. And since most sales of this nature close on the basis of greed or fear, risk of losing principal is ever at the forefront in the mindset of most Americans, especially with their retirement monies are on the line.

Remember the famous words FDR uttered during the Great Depression: “The only thing we have to fear is fear itself.” Well, until we get over it, I’m saying it again: Indexed insurance products may be the only game in town.